OPERATING EXPENDITURE 207
Within each category, the detail for monthly figures is based on logic. Take a simple
example. Suppose that you estimate that you will spend approximately $500 on station-
ery each month. Should you just enter $500 for each month? Or should you work out
exactly what will be purchased in which months and arrive at a projection such as $534
for January, $405 in February and so on?
The answer is self-evident when you apply cost-benefit logic. How much work is
required to arrive at the estimates – compared to the usefulness of the results? How large
are the amounts in relation to the overall plan? What is the importance of capturing any
erratic patterns?
For example, if you know that total expenditure will be tens of thousands of dollars a
month and spending on fuel will vary by around $50 a month you can safely use the same
amount for each month (the projected annual cost divided by 12). It would be pointless to
spend a day trying to achieve an exact projection. On the other hand, if you expected out-
lays on fuel to vary by 50% a month you should use a closer projection for each month.
DEPRECIATION AGAIN
By the way, when you built up your capital spending plans you created a depreciation
schedule. This gives you several ready-made entries. Just pull the depreciation figures into
the production and operating cost tables. For example, leasehold improvements in the
operating costs shown in Figure 9.4 (line E-22) are copied directly from the depreciation
schedule shown in Figure 9.2 (line D-13). As you can see, the work you do early on feeds
into the later tasks. Forecasting becomes easier and easier as you progress.
FORECASTING TRICKS
At this point, you might be saying that it is all very well for me to ask you to forecast oper-
ating costs, but more difficult for you to do. Well, in fact, there are some handy rules of
thumb that you can apply. The obvious one – I hardly like to mention this – is to assess
spending required for the year and divide by 12.
If you know that seasonal patterns make it a reasonably certain bet that
50% of your sales will occur in January, it would be dishonest to show the
monthly average rather than the actual projection (even if this would make
your year-to-date figures look very good for the first few months of the year).
208 CHAPTER 9 GETTING TO NET PROFIT
Other operating costs
(Read down under each heading)
Marketing and sales Occupancy Office
Delivery, shipping, etc. Dep’n, lease/f’hold
improvements
Depreciation, furniture
Brochures and printing Premises rental and taxes Depreciation, equipment
Advertising Heating and
air-conditioning
Leased furniture
Direct mail Electricity Small equipment
purchases
Exhibitions, seminars, etc. Water Stationery and printing
Promotional items and
events
Security Dues and subscriptions
PR, charities, community Building repairs and
maintenance
Books and periodicals
Other marketing and
sales
Other occupancy Other office
Communications Computers Travel and subsistence
Depreciation, telecoms Depreciation, computers Depreciation, vehicles
Telephone and fax Leased hardware Motor vehicle rental
Information services Software licences Motor vehicle expenses
Postage and courier Software maintenance Travel and subsistence
Messengerial Computer consumables Entertainment
Other communications Other IT Other TS&E
Professional fees Other fees and costs Other adjustments
Accounting fees Insurance Amortisation, start-up
costs
Audit fees Bank charges Profit and loss on disposal
of assets
Legal fees Relocation costs Bad debts and provisions
Other professional fees Sundry expenditure Contingency
Note: PR = public relations, TS&E = travel, subsistence and entertainment
OPERATING EXPENDITURE 209
Fixed relationships
Sometimes, one cost has a simple proportional relationship to another. Rental contracts for
office premises occasionally cover rent, air-conditioning and water – each charged at a fixed
rate per square foot or metre of floor area. Aside from allowing for an annual rent review,
each of these rows in the forecast is calculated in the spreadsheet as ‘office area in square
metres × rate-per-square-metre’. You can often calculate costs in relation to employee head-
count. For example, you might find that it is logical to project costs of computer printout
paper at some fixed multiple of the number of accountants that you have.
Steady rates of change
When any alternative rationale is absent, it is legitimate to assume a steadily increasing
(or more rarely decreasing) pattern, such as a 1% a month increase. Do not forget that this
compounds. For example, a 10% increase each month is 127% a year, not 120%.
Seasonal pattern
There might be a seasonal pattern that you can rely on. For example, you might project
annual heating and air-conditioning costs, and then allocate them among the months
according to some observed pattern (11% of the annual total in January, 9.5% in
February, 8.3% in March and so on).
Seasonal with steady change
The effects of a steady rate of change and a seasonal pattern can be combined. A quick fix
is to take a fixed change (i.e. +10%) over the same month a year earlier.
Bad debts
If you give credit, or invoice after delivery, chances are you will have uncollectable
debts. Lawyers and other misunderstood professionals realise that their clients
do not like to pay. These professionals frequently do not recognise their fees in
their accounts until payment is safely in the bank. For the rest of us, a percentage
of debts, or of debts over a certain age, is usually charged to operating costs as a
provision for bad debts. Show this as:
a charge (debit) entry in the operating expenses account;
matched by a deduction (credit) to accounts receivable on the assets side of
the balance sheet.
t
210 CHAPTER 9 GETTING TO NET PROFIT
CAREFUL!
When you are reviewing financial forecasts produced by others, watch for cheating.
The box above shows some tricks used – and watched for – by wily old dogs. Examples
include the following.
Inventory valuation – such as using LIFO (last-in first-out) valuation where
acquisition costs are falling in a high-tech business to boost profits and minimise
inventory shown on the balance sheet (see Chapter 8).
Depreciation, amortisation and depletion were discussed earlier in this chapter.
Stretching to ten years the life of the equipment in that new computer centre will make
operating costs look much lower this year. Similar tricks can be played with other
accruals accounting techniques, including capitalising costs, e.g. we won’t charge
R&D outlays to the expenditure account, we will put them on the balance sheet as
an asset.
Leasing was touched on in capital costs above. Other off-balance sheet
liabilities are considered in Chapter 10. It is not unknown for companies to sell
their inventories with an undertaking to buy them back when they are needed –
creating cash in the bank quickly and a hidden liability.
Areas where managers massage costs
(Read downwards)
Where no money changes hands With identifiable costs
Inventory valuation Capitalising costs (R&D, interest on
projects, etc.)
Depreciation Leasing
Amortisation Inflating or skimping on maintenance
and repairs
Depletion Discretionary bonuses
Provisions for payments to employees
(e.g. termination costs)
Sub-contracting
Provision for bad debts Service fees
Contingency reserve Timing errors
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